What Are The Criteria Of A Good Investment Appraisal Method

Earlier article looks at factors to consider BEFORE even conducting any investment appraisal.

Once we have determined the need to have such investment appraisal, we should next turn to looking for an appropriate Investment appraisal method.

Some of the criteria of a good investment appraisal method includes the following:

• it should recognizes the time value of money,

• it should considers the risk associated with an investment,

• it should takes the full economic life of the investment into account,

• it is not an arbitrary decision rule which relies on interpretation,

• it should focuses on cash flows

Click here for ALL TOPICS on Capital Investment Appraisal

Things To Do Consider Before Embarking on Any Investment Appraisal

Before we even start performing any investment appraisal method, we need to consider the following factors:

• does the investment fit the strategic direction of the company. We really need to understand the profile of the management whether they are risk-takers or risk-averse, profit or non-profit motivated and how’s their perception of the “full costs” of the investment,

• does the company have any budgetary constraints. Those under the capital budget should be able to sell across more easily whilst those needing additional funding will be quite difficult to get approval,

• have we consider other way(s) to improve the attractiveness of the investment by choosing the appropriate timing and on a different scale so as to reap economies of scale,

• how does the investment fit into other stakeholders of the company. This need not necessarily be the shareholders alone as the investment might impact redundancies ( employees), environment, safety and others,

• any other investment opportunities that might be missed.

Click here for ALL TOPICS on Capital Investment Appraisal

Understand What Is Present Value Of Money

Earlier article touched on time value and future value of money, here in this article, we look at what it means by Present Value of money:-

Understand What is Present Value Of Money?

Simply, the present value is the amount that must be invested NOW to reach a given sum at a given point of time in the future, using the compounding interest rate. In this case, the present value is actually the opposite of future value. Hence, to get the present value, we can then use the compound interest to be the factor to discount the future value back to the present value. Earlier illustrated in the article on the future value of money, the $12,100 is receivable in Year 2 using the compound rate of 10%. By using the 10% as the discount rate, we can then discount this future value of $12,100 at 10% back to the present value of $10,000 which is amount that must be invested Now.

Time Value, Future Value & Present Value Concepts

By understanding the time value of money and the future value concept, we can then be able to appraise investment project that has characteristics of up-front cash outflow and future cash inflows which takes a few years to recoup. Click here for ALL TOPICS on Capital Investment Appraisal

Understand What Is Future Value Of Money

Earlier article described what is time value of money, this article looks at the meaning of :

Future Value Of Money:-

The future value is merely the amount an investment would grow to if it accumulates interest at a certain interest rate COMPOUNDED over the terms of the investment. To understand the future value of money, we need to understand compound interest. For example, if we have cash, $10,000 and if we were to put this $10,000 into a yearly time deposit which attracts a yearly interest rate of 10%. This present deposit of $10,000 will be growing at a COMPOUNDING INTEREST rate of 10% namely in Year 1 grow by $10,000 x 1.10=$11,100 which again in Year 2 grow by $11,100x 1.10 = $12,100 Therefore, for Now, we can see that our $10,000 has a future value of $11,100 in Year 1 and $12,100 in Year 2 Click here for ALL TOPICS on Capital Investment Appraisal